Britain's Path To A 19% Corporate Tax Rate

If the U.S. reduced its Federal corporate tax rate to 15%, it would produce a combined effective corporate tax rate of about 19% -- the same as Britain today. There are now 15 governments among the OECD with a corporate tax rate of 22% or less. On average, they get more revenue from this (2.26% of GDP) than the U.S. gets today with a 39% combined rate (2.05% of GDP). Britain gets about 2.6%.

In the 1970s, Britain’s corporate tax rate used to be 52%. This did not produce any more revenue, as a percentage of GDP, than the 19% rate today. Let’s take a look at Britain’s history of corporate tax rates and revenues since 1971:

Britain: Corporate tax rates, and revenue/GDP from the corporate tax

Nathan Lewis

This story is not quite as clean and definitive as I hoped for. Real history is sometimes messy. Mostly, tax revenues have followed the economy as a whole, rising during booms and falling during recessions. However, one reason (among many) for the booms in the mid-1980s and late 1990s was the decline in corporate tax rates itself. Lower taxes, by allowing a healthier economy, produced higher revenues. The highest revenue/GDP figures were while the 52% rate was cut to 35%, as part of the Thatcher tax cuts.

Since 2005, lower rates have been accompanied by something of a downtrend in revenues/GDP. Nevertheless, the government still gets more revenue than the U.S. More corporate tax cuts are planned for the future. This chart doesn’t show GDP itself. If GDP grows more with a lower tax rate than with a higher – as one would expect it to – then the total tax revenue can easily be higher with a lower rate, even if that lower rate produces some falloff in revenue/GDP.

Tax revenue is not maximized when revenue/GDP is maximized. Not at all. Over a period of time – let’s say twenty or thirty years – a high-growth economy can easily be twice as large, in nominal GDP, than if the same economy had a lower growth path. The result would be that a government would have more revenue with a tax system that generates 20% of GDP (and double the GDP) than one that generates 35% of GDP (and half the GDP). Another twenty years later, the high growth economy could be four times larger.

Another thing that often happens is: when an economy is doing well, helped by lower taxes, it tends to allow a government to reduce spending. Let’s look at Britain again:

Britain: Government spending as a percentage of GDP

tradingeconomics.com

We can see the huge decline in government spending/GDP, from around 50% in 1980 to a low of around 35% in 1999. This was the big Thatcher-era privatization and deregulation of the British economy. I say that it happened because the tax cuts – which came first – made the private economy a viable alternative to socialist solutions. When the private economy is doing badly, as it was in the 1970s, it does not present a viable alternative, and governments drift toward socialism. Recessions after 2000 and again in 2008 led to big increases in government spending in Britain, but the trend has headed down again.

We’ve had the same patterns in the U.S.: spending goes up when the economy is sputtering, and goes down when the economy is healthy.

These changes in spending are much larger than changes in tax revenue, possibly leading from lower rates. For example, if a lower corporate tax rate led to a 0.5% or 1.0% decline in revenue/GDP, as one might argue was the case in Britain, that could be easily counterbalanced by a 5%-of-GDP decline in spending that might come about when the economy is healthier. Thus, lower tax rates lead to smaller deficits.

However, you need to do the tax cuts first, as Britain did in the 1980s and again after 2010. If you try to cut spending first, and then cut tax rates (maybe) later “when deficits are smaller,” what generally happens is that there is a lot of pushback against the spending cuts, because the economy is doing badly. The result is that spending is not actually cut very much. This then leads to a cancellation of the tax reform plans. Instead, reduce the rates first, or at least, simultaneously; then follow with spending cuts.

A Tory victory in 2010 was followed by the reduction in the corporate tax rate from 28% to 19% today. During 2010-2015, the Tories also reduced the number of government workers in Britain from 6.3 million to 5.3 million – an enormous accomplishment, as anyone who is familiar with U.S. politics can understand. I claim that the two are related, just as they were in the 1980s. A healthy private economy allows a government slimdown; lower taxes allows a healthy private economy. First things first. Was this “austerity”? Hardly – it didn’t hurt a bit, and a good time was had by all. Government spending has declined by about 6% of GDP between the peak in 2009 and today.

A better solution would be a simplified “flat tax” system, much like the one that allows Hong Kong to generate roughly twice as much revenue/GDP as the U.S. from the corporate income tax, at a 16.5% rate. This is perhaps a bit of an outlier, but the basic principle applies. You can get more revenue, a healthier economy, and less spending, with lower tax rates. Much lower. So, don’t be shy about it.